Understanding SECURE Act 2.0’s Penalty-Free LTC Insurance Retirement Plan Distribution Provision

A provision coming out of SECURE 2.0 (2022) may allow for penalty-free distributions from certain qualified retirement plans to pay long-term care (LTC) insurance premiums without the 10 percent early withdrawal penalty. This provision allows qualified retirement plan participants younger than age 59.5 to take plan distributions in order to pay the premiums for certain LTC insurance contracts. This column discusses this provision and how it may affect some federal employees who are traditional Thrift Savings Plan (TSP) participants enrolled in the Federal Long-Term Care Insurance Program (FLTCIP).

Using Qualified Money to Help Pay LTC Insurance Premiums

Many employees automatically save money for their future retirement. The most convenient and efficient way is through payroll deduction in which contributions to a qualified retirement plan are deducted from an employee’s salary and contributed to a qualified retirement plan. Examples of qualified retirement plans include 401(k), 403(b), and 457 plans. The Thrift Savings Plan (TSP) is technically not a qualified retirement plan but shares most of the features of a qualified retirement plan.

Millions of employees over the years have contributed hundreds of thousands of dollars to qualified retirement plans. Some employees have contributed millions. One reason that individuals purchase LTC insurance is to help protect their retirement funds.

But here is the dilemma: Many employees purchase LTC insurance when they are in their 40’s and 50’s. LTC insurance premiums generally increase over the years. To help pay LTC insurance  premiums, some  LTC insurance policyholders have to make  withdrawals from their qualified retirement accounts. However, for qualified retirement plans, there is a 10 percent early withdrawal penalty if an employee withdraws retirement funds  before he or she is age 59.5.

This provision coming out of SECURE Act 2.0 changes that. Beginning with distributions made from qualified retirement plans after December 29, 2025, a limited portion of a qualified retirement account may be withdrawn to pay LTC insurance premiums without the 10 percent early-distribution penalty if the retirement plan participant is under age 59.5.

The following is a summary of the SECURE Act 2.0 provision  allowing penalty-fee LTC distribution from retirement plans:

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1. Starting December 30, 2025, qualified defined contribution plans )this includes 401(a), 401(k), 403(a),403(b) and 457(b) plans) can offer penalty-free withdrawals in order to LTC insurance premiums. The withdrawals must be used to pay “certified long-term care insurance premiums” for an employee and the employee’s spouse. Note that SECURE Act 2.0’s use of “employee” in this provision suggests that only active employees enrolled in these retirement plans may request these withdrawals. Former employees enrolled in these retirement plans and who left their company-sponsored retirement plan are not eligible to make these penalty-free withdrawals.
2. Eligible distributions. An employee must use the distributions to pay premiums for certified long-term care insurance under the following requirements : (1) A qualified LTC contract under Internal Revenue Code (IRC) Section 7702B(b); (2) A life insurance or annuity contract with a rider or other provision that covers qualified LTC services and is treated as a separate LTC insurance contract under (IRC) code 7702B; or (3) A life insurance contract with a rider or other provision providing accelerated death benefits to pay the costs of qualified LTC if the insured becomes chronically ill.
3. Dollar limitation. Every year, employees can request qualified retirement plan distributions, up to the least of the following: (1) The premium paid by or assessed to the participant during the year; (2) 10 percent of the employee’s vested retirement account balance; and (3) $2,600 (2026- indexed to inflation and increases annually).
4. Defined contribution plans. The statue allows certain defined contribution retirement plans. These include: (1) Most 401(k) plans; (2) Many 403(b) and 403(a) annuity plans; and (3) Some governmental 457(b) plans. Note that IRAs are not considered “eligible retirement plans.” Final IRS guidance could change that.

A critical nuance: Retirement plan sponsors are not required to offer this feature. Federal employees are advised that the Thrift Savings Plan does not currently offer this feature. That means federal employees who are enrolled in the FLTCIP and younger than age 59.5 must find alternatives to help pay their FLTCIP insurance premiums.

Some suggestions:

‧ (1) If a federal employee is married and their spouse works for a private company that offers a qualified retirement plan that allows penalty-free  withdrawals to help pay LTC insurance premiums, then those withdrawals could be used to reimburse the employee and spouse for FLTCIP premiums paid. The spouse must request withdrawals in the same taxable year in which the premiums are paid; and

‧ (2) If an employee owns a health savings account (HSA) then tax-free withdrawals can be made from the HSA to pay LTC insurance premiums for the employee and the employee’s spouse.

Risks, Limits and Questions

Every dollar an employee withdraws – even penalty-free – from any retirement account is a dollar that no longer compounds for retirement. Many individuals are advised to purchase LTC insurance when they are younger (in their 30’s and 40’s) when they are insurable and more likely able to afford to pay the LTC insurance premiums. But as they get older, the insurance premiums will most likely increase. Withdrawing retirement account savings to pay insurance now could mean less retirement income later and being able to pay the LTC insurance premiums later.

An employer must adopt and administer this feature of penalty-free distributions from an employer-sponsored retirement plan. The employer has the right to drop this SECURE Act 2.0 provision at any time.

Guidance is Still Evolving

Some details about this SECURE Act 2.0 provision are still evolving and will depend on IRS regulations and additional guidance. These details  include:

‧ Exact reporting codes for IRS Form 1099-R (Distributions from Pensions, Annuities,   Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.).

‧ Treatment of certain hybrid policies and riders; and

‧ Coordination with state tax rules.

Edward A. Zurndorfer is a CERTIFIED FINANCIAL PLANNER™ professional, Chartered Life Underwriter, Chartered Financial Consultant, Chartered Federal Employee Benefits Consultant, Certified Employees Benefits Specialist and IRS Enrolled Agent in Silver Spring, MD. Tax planning, Federal employee benefits, retirement and insurance consulting services offered through EZ Accounting and Financial Services, and EZ Federal Benefits Seminars, located at 833 Bromley Street – Suite A, Silver Spring, MD 20902-3019 and telephone number 301-681-1652. Raymond James is not affiliated with and does not endorse the opinions or services of Edward A. Zurndorfer or EZ Accounting and Financial Services. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.

Ed Zurndorfer, EA, ATA, CFP®, CLU®, ChFC®, CEBS®, ChFEBC℠: Federal Employee Benefits Expert

A former career Federal employee, Ed has published a staggering 1,200+ separate articles on Federal Benefits and Retirement!
Just “Google” his name, and you are likely to find a plethora of sites that contain his writings. Drawn to its mission to reach, teach
and serve Feds, Serving Those Who Serve is the only financial planning practice with which Ed has chosen to affiliate in over
20 years teaching. In addition to conducting Federal Benefits seminars for Serving Those Who Serve, you can find Ed’s
writings here on our blog in the FedZone, and on Fed-Soup, MyFederalRetirement, FederalNews Radio and NITP.

He is a member of the Maryland Society of Accountants, the National Association of Enrolled Agents, the International Society of Certified Employee Benefits Specialists, the Financial Planning Association, the National Association of Health Underwriters,
and the Society of Financial Service Professionals. Since 1999, Ed has taught many thousands of Federal employees about
their benefits, in person and at Federal agencies all over the country. Ed is a true national treasure.

Edward A. Zurndorfer is a CERTIFIED FINANCIAL PLANNER™ professional, Chartered Life Underwriter, Chartered Financial Consultant, Chartered Federal Employee Benefits Consultant, Certified Employees Benefits Specialist and IRS Enrolled Agent in Silver Spring, MD. Tax planning, Federal employee benefits, retirement and insurance consulting services offered through EZ Accounting and Financial Services, and EZ Federal Benefits Seminars, located at 833 Bromley Street – Suite A, Silver Spring, MD 20902-3019 and telephone number 301-681-1652. Raymond James is not affiliated with and does not endorse the opinions or services of Edward A. Zurndorfer or EZ Accounting and Financial Services. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.